There has been some more talk about fixing the Alternative Minimum Tax since the Democrats took over Congress (also see my earlier post). Maybe we can actually get some tax reform in the next couple years? That would be a real miracle. The Bush administration’s failure to get Social Security reform and failure to get any tax reform loom large in my evaluation of its overall success.

So here is a free idea for the Democrats. From this point on I start charging.

The issue of revenue neutrality is not being looked at creatively. Discussion has focused on making sure that if some people gain from tax reform, others will have to lose, if we are to maintain revenue neutrality. This ignores the fundamental inefficiency of taxes, which is that they drive a wedge between what one individual earns and what that individual takes home. The wedge causes individuals to forego income-earning possibilities that do not yield enough after-tax income to compensate for the opportunities sacrificed as a result of earning the income (e.g., leisure). If the tax wedge is reduced, then individuals will earn more, yielding more tax revenue, and making themselves better off.

The problem has always been that if you reduce taxes to reduce the wedge, you lose a lot of revenue on income that would have been earned and taxed anyway. This makes tax reduction costly from the point of view of the government’s treasury. The point is very similar to the concept of marginal revenue in the economics of pricing: if a company reduces its price to sell more product, it picks up some additional revenue from the new units sold, but if it has to reduce price on all the units that would have been sold anyway, then total revenue could actually decline.

But the principle remains: tax rate reduction is mutually beneficial, between individuals and the government. In principle, we should be able to strike a bargain that makes both entities better off.

So here is how we might do that. Now all the details of this are not worked out, but I am rather intrigued by the idea.

Right now, I don’t really know if my marginal tax rate for income earned in 2007 is going to be around 42% or around 26%. It will be 42% if I don’t get caught by the AMT and it will be 26% if I do get caught by the AMT. So let me choose at the beginning of the year how I want to be taxed. I will promise the IRS that, so long as my income is at least as high as it was in 2006, then I will pay at least the same amount of taxes that I paid in 2006. But, and this is the kicker, for any additional income that I earn over and above my 2006 income, I will pay only the AMT marginal tax rate, i.e., 26%.

Imagine that I have an opportunity to make an additional $10,000 in 2007. If my marginal rate were 42%, my take-home pay would only be $5800. At that rate, I might choose to spend that time out at my camp instead of earning the income. But if my marginal rate were only 26%, I would forego $7400 by going to camp instead of to work.

So promise me a lower rate on only my incremental income, and I will earn more. The IRS will take in more revenue than it did before, and possibly more than it would have without this tax innovation (I say possibly more since some people would have taken the income earning option even with the higher tax rate).

The point of this scheme is to make tax reform revenue neutral at the level of the individual, not necessarily across individuals. And we define revenue neutrality relative to the prior year’s tax payments.

To make this even more attractive, you could let me “buy down” my marginal tax rate on new income by foregoing some deductions such as mortgage payments. So I would agree to pay 26%, say, on more of my income (I won’t deduct mortgage interest) if you lower the rate of taxation on new income I earn to, say, 24%.

This idea is very similar to health insurance plans that require us to choose at the beginning of the year what kind of plan we want, and how much money we want to put into a reimbursement account. Let’s extend that principle to taxation, remove some inefficiency, and make everyone better off.

Anyone who knows me knows that I care a lot about the state of fisheries, both fresh and saltwater. I value fisheries for recreation and for food, as well as for their overall role in a healthy ecosystem.

But I cannot support the headline claim of this recent study. A story in the Seattle Times ,"Will seafood nets be empty? Grim outlook draws skeptics," tears it apart particularly well, showing first the graph that supposedly supports the prediction of complete collapse in 45 years. It looks like the authors were not content to simply project a trend forward, they actually projected a nonlinear trend forward -- a nonlinear trend with increasing negative slope!! Even worse, one of the authors accidentally included the Seattle Times in an email meant for someone else. Quoting from the ST article:

"In a note to colleagues that was mistakenly sent to The Seattle Times, Worm wrote that the projection could act as a "news hook to get people's attention."

"One reason why nobody cares about marine biodiversity is that there seemed no clear end in sight," he continued. "... Well, it's time to wake up — IF the current trend continues we will see drastic consequences in our own lifetime."

I know how nice it is to get one's research results written up well in the national media. But doing bad science to get people's attention is really sad.

It was getting a little hard to defend some parts of the Republican Party's agenda and actions, so I am not entirely heartbroken over the election. And the rest of the world should note how quickly and smoothly the US can change its political standing. The system does work. I think a strong case can even be made for Allen to not challenge the Virginia result. The chance of overturning it would seem to be low, while the benefits of taking the high road seem large.

What I long for is a political party that would be conservative on economics (especially spending and regulation), and on national defense, but liberal on many social issues, particularly those concerning individual rights and privacy. If the Democrats could claim that ground, they would get a lot of Republican support. Or, I could imagine a part of the Republican Party discarding some of the more religious, social conservatives for a more Libertarian leaning party. The problem there is that we would have three parties, with the two on the right sure to lose to the one on the left. Could a three party system be sustained in the US today? Maybe.

I worry that the Democrats will go too far to satisfy those furthest to the left on spending, regulation, and general "government is the answer to all questions" issues. If they resist that, relying more on Bill Clinton's views on the role of government in the economy, they could be a real powerhouse.

See my post immediately below on the lack of Bass signs around Hanover during the recent campaign. Now it seems that some of the Bass signs may have been stolen.

I was reading a story in the Valley News last night about someone in Enfield who had been arrested for taking Bass signs from alongside the road. The police followed the individual home and, when the perp failed to respond to their requests to appear at the front door, they knocked the door down! The poor fellow was arrested on two counts of possession of stolen property.

As I have had my own campaign signs stolen from my front yard, and my Bush sticker ripped off my truck's bumper, I was feeling pretty good about this story. But then I realized I knew the culprit! He is the son of a friend, and he used to babysit for my kids all the time! Ah, the follies of the youth. I hope they go a little easy on him. I don't think Bass lost because of a few signs being stolen.

Monday, November 06, 2006

So I have observed many electoral campaigns in the Upper Valley of NH, having lived here now for 23 years. Republicans have been an endangered species for a long time around here, and it is getting even more lonely of late. That said, I have never seen such a dearth of Republican campaign materials. No signs, no posters, no ads in the papers...Well, one sad little ad in the Valley News half-heartedly telling Republicans that their vote matters. Meanwhile, the Democrat Hodes has simply blanketed the landscape with campaign stuff. I can't drive anywhere without Hodes intruding on my thoughts.

If Charlie Bass loses his House seat, I will not be surprised. I understand better than anyone the idea of optimizing use of resources, but the incremental cost of doing a LITTLE SOMETHING even in a Democrat stronghold is so low that it has to be worthwhile. The complete lack of any effort around here makes me suspect that the Bass campaign is asleep at the wheel. Not a good indicator.

Well, I would be perfectly happy if the result tomorrow is Democratic control of the House and Republican control of the Senate. For a Libertarian, gridlock reads: Less new legislation.

Tomorrow should be interesting. Of course, given the last couple elections, we might not get final results for some time.

About Me

I was born in the Upper Peninsula of Michigan, went to Northern Michigan University undergrad and UCLA for my PhD in economics. I am the Senior Associate Dean and Professor at the Tuck School of Business at Dartmouth College. I lean libertarian, but for lack of political success on that front I tend to support the Republican Party.
The usual boilerplate applies: What I write here represents only my views, not those of my employer.